The Cost of ‘Soaking the Rich’

March 22, 1948

If the Republicans and Democrats in Congress were not mainly engaged in trying to outmaneuver each other for votes, and if they understood the real economic situation that confronts them, they would be debating an entirely different measure from the present tax bill. They would try to apply the ax first of all not to taxes but to expenditures. If they concluded that overall spending could not in fact be substantially cut, they would not be planning an inflationary slash in taxes of $4,800,000,000 to $6,500,000,000.

But they might be considering, not how many voters could be exempted completely from income taxes in order to support a short-lived illusion that the present enormous tax burden can be borne by a minority, but how far excessive tax rates on high incomes should be reduced to restore incentives to production and investment. For the funds that the present income-tax structure takes are precisely those that would have gone principally into investment—that is, into improved machines and new factories to provide that increased labor productivity which is the only permanent and continuous means of increasing wages. An even more important effect of taking so much of the taxpayer’s earnings, in fact, has been to diminish or remove the incentives to bring such earnings into existence.

About a year ago in this column (April 7, 1947) I presented a table, based on income-tax returns, which brought out some striking facts. In the period between the three years 1926–28 and the year 1942, our total national income increased 58 percent. But total incomes over $300,000 fell in that period by 77 percent. If individual incomes in each group had risen by the same percentage as the national income, total incomes over $300,000 would have risen by a much greater percentage (because all incomes previously above $190,000 would in 1942 have been counted among incomes over $300,000). Yet even if the aggregate of such $300,000 incomes had simply risen in proportion to the whole national income, the total of such incomes in 1942 would have been seven times greater than it actually was.

The top rate applicable to incomes over $300,000 in 1926–28 was 25 percent. The top rate in 1942 was 88 percent. We are justified in assuming that the main cause of the shrinkage in incomes over $300,000 was precisely this increase in the top rates. If the upper income brackets had continued to be taxed at only 25 percent, and if these incomes had increased in the aggregate no more than the national average, the yield to the Treasury would have been about 50 percent greater than it actually was at a tax rate of 88 percent.

In other words, the extremely high income-tax rates are self-defeating. Few people realize how drastically revenues from the high incomes have shrunken. Today the combined normal and surtax rate (after the 5 percent reduction) is 50 percent on all net income between $18,000 and $20,000. Suppose the combined rate stopped at this level, instead of mounting progressively on higher income brackets to a maximum of 86½ percent. What would be the effect on total revenues? Calculations furnished to me by the Tax Foundation indicate that the loss of revenue—if incomes above $18,000 remained unaffected—would be about $1,095,000,000 for the fiscal year 1948–49. This would be less than 5 percent of total individual income-tax revenues and less than 2½ percent of total budget receipts.

Obviously, however, incomes above $18,000 would not remain unaffected by such a drastic cut in top-bracket rates. Such incomes would expand far beyond what they otherwise would be. Treasury revenues would actually be higher with a top rate of 50 percent than with a top rate of 86½ percent.

But far more important than the effect on Treasury revenues would be the effect on national welfare. The national income would be higher not because the high incomes themselves would be larger; but mainly because the lower rates would both permit and encourage high investment. It is this investment that would raise national production and real wages. In our efforts to soak the present rich we have been soaking the future poor.